Debt, Deficits, and Demographics

For much of the last three decades, policy debates in the United States have been dominated by a quixotic concern about deficits, debt, and demographics. This concern has distracted policy from fundamental economic issues that have much more direct bearing on economic well-being, most notably the growth (and bursting) of the housing bubble in the last decade. While large deficits can have a negative impact on economic growth, this impact has been hugely misrepresented in public debates.

In fact, contrary to what political figures often assert, it is almost impossible to envision a scenario in which deficits and debt prevent future generations from on average enjoying higher standards of living than we do today. Many households have seen a decline in living standards in recent years, but this has been due to increasing inequality, not a decline in the nation’s productive capacities. The trend towards increasing inequality poses a far greater threat to the living standards of future generations than the potential negative impact of deficits. Unfortunately, discussions of the debt and deficit often distract from discussions of the factors affecting the distribution of income.

The first section of this paper discusses the economy’s recent growth and projected future growth. It compares the projected gains from continued growth and contrasts these with the impact of an aging population. Under any plausible scenario, the benefits from growth will swamp any negative impact on living standards from an aging population.

The second section examines how deficits can pose a drain on the economy. Specifically, it will point out the distinction between a deficit when the economy is near full employment and a deficit run when the economy has a large number of unemployed workers and a large amount of excess capacity. In the latter case, there is really no way that the deficit can be seen as imposing a drain on the economy. In fact, deficits in the latter case are likely to increase the well-being of future generations.

The third section points out that the debt does not in any way provide a measure of inter-generational equity. The debt is a commitment from the public as a whole to the owners of the debt. This can present distributional issues within a generation, but there is no way in which the debt in any way measures the extent to which current generations have made future generations worse off. In fact, the debt as conventionally reported is an arbitrary number that tells us very little about anything.

The fourth section examines the long-term deficit projections that have caused so much panic in policy circles. Specifically, it examines the projections for Social Security and Medicare. It shows that the projected shortfalls in Social Security can be relatively easily filled, especially if the pattern of upward redistribution of income that we have experienced over the last decade is stopped. Addressing the projected shortfall would be even easier if upward redistribution of the last three decades were reversed.

Instead, the main reason that deficits are projected to rise to dangerous levels is that private sector health care costs are projected to continue to hugely outpace the rate of economic growth. If these projections for health care costs prove accurate, it will have a devastating impact on the economy regardless of what is done with public sector-financed health care programs. Given this fact, an honest discussion would focus on ways to reform the health care system, not just containing public sector spending on health care. Discussing this projected explosion of health care costs as a deficit problem is fundamentally misleading.

The conclusion explains that we need to focus directly on the issues that will affect the future state of the economy if we care about the well-being of future generations. The deficit is very much secondary in this picture.